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Speech by Governor Brainard on Financial Stability Implications Of For release on delivery 1:25 p.m. EDT March 23, 2021 Financial Stability Implications of Climate Change Remarks by Lael Brainard Member Board of Governors of the Federal Reserve System at “Transform Tomorrow Today” Ceres 2021 Conference Boston, Massachusetts (via webcast) March 23, 2021 I want to thank Ceres for inviting me to join this discussion. Let me start by noting that these are my own views and do not necessarily reflect those of the Federal Reserve Board or the Federal Open Market Committee.1 Climate change is already imposing substantial economic costs and is projected to have a profound effect on the economy at home and abroad.2 Future financial and economic effects will depend on the severity of the physical effects of climate change and the nature and speed of the transition to a sustainable economy.3 Financial market participants that do not put in place frameworks to assess and address climate-related risks could face significant losses on climate-sensitive assets caused by environmental shifts, by a disorderly transition, or both. Conversely, robust risk management; scenario analysis; consistent, comparable disclosures; and forward plans can help ensure the financial system is resilient to climate-related risks and well positioned to support the transition to a sustainable economy.4 1 I am grateful to Elizabeth Kiser of the Federal Reserve for her assistance in preparing this text. 2 See David R. Reidmiller, Christopher W. Avery, David R. Easterling, Kenneth E. Kunkel, Kristin L. M. Lewis, Thomas K. Maycock, and Brooke C. Stewart, eds. (2018), Fourth National Climate Assessment, vol. II: Impacts, Risks, and Adaptation in the United States (Washington: U.S. Global Change Research Program), https://dx.doi.org/10.7930/NCA4.2018. 3 On the effects of global warming of 1.5°C above pre-industrial levels and related global greenhouse gas emission pathways, in the context of strengthening the global response to the threat of climate change, sustainable development, and efforts to eradicate poverty, see Valérie Masson-Delmotte, Panmao Zhai, Hans-Otto Pörtner, Debra Roberts, Jim Skea, Priyardarshi R. Shukla, Anna Pirani, Wilfran Moufouma- Okia, Clotilde Péan, Roz Pidcock, Sarah Connors, J. B. Robin Matthews, Yang Chen, Xiao Zhou, Melissa I. Gomis, Elisabeth Lonnoy, Tom Maycock, Melinda Tignor, and Tim Waterfield, eds. (2018), Summary for Policymakers of IPCC Special Report on Global Warming of 1.5°C Approved by Governments (Geneva: Intergovernmental Panel on Climate Change), https://www.ipcc.ch/2018/10/08/summary-for- policymakers-of-ipcc-special-report-on-global-warming-of-1-5c-approved-by-governments. 4 See, for example, Financial Stability Board (2020), The Implications of Climate Change for Financial Stability, (Basel: FSB, November 23), https://www.fsb.org/wp-content/uploads/P231120.pdf; and Climate- Related Market Risk Subcommittee, Market Risk Advisory Committee, U.S. Commodity Futures Trading Commission (2020), Managing Climate Risk in the U.S. Financial System (Washington: CFTC, September 9), https://www.cftc.gov/sites/default/files/2020-09/9-9- 20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20- %20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf. - 2 - Macroprudential and Microprudential Approaches It is increasingly clear that climate change could have important implications for the Federal Reserve in carrying out its responsibilities assigned by the Congress.5 Given the implications of climate change for both individual financial institutions and the financial sector as a whole, we need a framework that incorporates both microprudential and macroprudential considerations. The Federal Reserve created a new Supervision Climate Committee (SCC) to strengthen our capacity to identify and assess financial risks from climate change and to develop an appropriate program to ensure the resilience of our supervised firms to those risks.6 The SCC’s microprudential work to ensure the safety and soundness of financial institutions constitutes one core pillar of the Federal Reserve’s framework for addressing the economic and financial consequences of climate change.7 5 A recent survey of central banks found a large majority view it as appropriate “to act within their existing mandate to mitigate climate-related financial risks” that “could potentially impact the safety and soundness of individual financial institutions and could pose potential financial stability concerns for the financial system.” See Basel Committee on Banking Supervision, Bank for International Settlements (2020), Climate-Related Financial Risks: A Survey on Current Initiatives (Basel: BCBS, April), https://www.bis.org/bcbs/publ/d502.pdf; see also Nick Robins, Simon Dikau, and Ulrich Volz (2021), Net- Zero Central Banking: A New Phase in Greening the Financial System, (London: Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science, March), https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2021/03/Net-zero-central- banking-1.pdf. For overviews of climate change and economic damage, see, for example, Maximilian Auffhammer (2018), “Quantifying Economic Damages from Climate Change,” Journal of Economic Perspectives, vol. 32 (Fall), pp. 33–52; Solomon Hsiang and Robert E. Kopp (2018), “An Economist’s Guide to Climate Change Science,” Journal of Economic Perspectives, vol. 32 (Fall), pp. 3–32, https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.32.4.3; and Solomon Hsiang, Robert Kopp, Amir Jina, James Rising, Michael Delgado, Shashank Mohan, D. J. Rasmussen, Robert Muir-Wood, Paul Wilson, Michael Oppenheimer, Kate Larsen, and Trevor Houser (2017), “Estimating Economic Damage from Climate Change in the United States,” Science, vol. 356 (June), pp. 1362–69. 6 See Federal Reserve Bank of New York (2021), “Kevin Stiroh to Step Down as Head of New York Fed Supervision to Assume New System Leadership Role at Board of Governors on Climate,” press release, January 25, https://www.newyorkfed.org/newsevents/news/aboutthefed/2021/20210125. 7 See Lael Brainard (2021), “The Role of Financial Institutions in Tackling the Challenges of Climate Change,” speech delivered at the Institute of International Finance U.S. Climate Finance Summit: Financing a Pro Growth Pro Markets Transition to a Sustainable, Low-Carbon Economy, Washington, February 18, https://www.federalreserve.gov/newsevents/speech/brainard20210218a.htm. - 3 - Climate change and the transition to a sustainable economy also pose risks to the stability of the broader financial system. So a second core pillar of our framework seeks to address the macrofinancial risks of climate change. To complement the work of the SCC, the Federal Reserve Board is establishing a Financial Stability Climate Committee (FSCC) to identify, assess, and address climate-related risks to financial stability. The FSCC will approach this work from a macroprudential perspective—that is, one that considers the potential for complex interactions across the financial system. From a microprudential perspective, the Federal Reserve’s Supervision and Regulation Report discusses how the effects of climate change can manifest in the financial system via traditional channels like credit, market, operational, legal, and reputational risks that affect the safety and soundness of individual firms.8 From a macroprudential perspective, our Financial Stability Report outlines how climate change could increase financial shocks and financial system vulnerabilities that could further amplify shocks.9 Microprudential and macroprudential objectives are often aligned. For example, consistent disclosures are important not only to enable individual financial firms to measure and manage their exposure to climate-related financial risks, but also to support financial stability more broadly by helping the market to accurately price that risk. Given 8 See Board of Governors of the Federal Reserve System (2020), Supervision and Regulation Report (Washington: Board of Governors, November), https://www.federalreserve.gov/publications/files/202011- supervision-and-regulation-report.pdf. 9 See Board of Governors of the Federal Reserve System (2020), Financial Stability Report (Washington: Board of Governors, November), https://www.federalreserve.gov/publications/files/financial-stability- report-20201109.pdf. - 4 - the importance of consistent, comparable, and reliable disclosures to financial stability and prudential objectives, mandatory disclosures are ultimately likely to be important.10 There are situations, however, where microprudential and macroprudential goals do not fully align so that it is important to take into account the implications both for individual firms’ safety and soundness and also for the broader financial system. For example, the use of climate-related risk mitigants such as insurance or financial derivatives may shift risk away from a particular financial institution but may not reduce or eliminate risk from the system as a whole. In developing a framework to address climate-related financial risks, we need to be mindful of this cascade of effects and the implications across the Federal Reserve’s range of responsibilities. Financial System Shocks and Vulnerabilities Arising from Climate Change Our macroprudential work program is focused on assessing not only potential climate shocks, but also whether climate change might make the financial system more vulnerable in ways that could amplify these shocks and
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